Companies must think more radically while still pursuing incremental innovations.

Most innovations fail and it’s easy to see why. They are expected. They are unimaginative, boring, and fail to excite or fill any real need. Indeed, most so-called innovations aren’t innovative. They are mundane line extensions to existing products and services that have no currency with cynical, time-starved customers. So why do companies keep churning out me-too innovations that have no magic or address problems that have been adequately met elsewhere?

I think part of the problem is that most companies put most of their innovation effort into what I’d call horizon-one type innovations. These are low-risk innovations that aim to incrementally extend the existing business. They usually make sense internally but most customers can do without marginal innovations, especially if switching from one product to another costs valuable time or money.

A few companies look beyond this activity to horizon-two type innovations. These are new products or services that aim to create entirely new categories within an existing market. This type of blockbuster innovation is difficult, but there are big rewards for any company that’s smart enough and persistent enough to try.

The third area of activity is horizon-three type innovation. But outside of technology this is as rare as a red carpet no show by Paris Hilton. Horizon-three type innovations seek to disrupt existing markets through the use of new business models, processes, or technology. This is an area where old industries are remodelled and where emerging science and technology is harnessed to address demand that does not seem to exist. It is an area at the very edge of what’s possible where comments like ‘ridiculous’ are often a favorable response because few companies have the imagination or the courage to follow such bold moves.

This is where the really big money is.

According to an INSEAD study, 86% of innovation is low risk and generates around 30% of current company profits. The remaining 14% of innovation is radical but generates over 60% of current company profits. I’d add to this that unless you are actively looking at horizon-three type innovations, chances are your company won’t be around in another 20 years to invest in lower risk incremental innovations. For example, only 26% of the companies in the Fortune 100 in 1980 were also on the same list in 2001. In other words, playing it safe 100% of the time is a dangerous business. So ‘innovate or evaporate,’ as author and innovation expert James M. Higgins says.

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Another reason innovations fail is that successful innovations that remain in market are quickly copied by competitors. Not only that, competitors playing a ‘follower strategy’ are not disabled by many of the costs associated with bringing a new idea to market. Fast followers can quickly learn from the mistakes of the original innovator who is invariably bogged down by the double whammy of internal resistance and external inertia.

For example, can you imagine the money Unilever must have spent to put black laundry detergent (for washing black clothes) on shelf only to find archrival Procter & Gamble putting an almost identical product on shelf a few moments later? (I actually forget who was first and who was the follower–but that’s my point).

Furthermore, companies often seriously underestimate the hidden costs associated with innovations, so what looks like a success on paper is often a commercial flop over the longer term when hidden costs like logistics are taken into account. Incremental innovation (horizon-one type innovation) is something companies need to do to stay in the game, but it rarely delivers any long-term competitive advantage unless you can create continuous company-wide innovation as a core competency.

This is not to say that companies (or individuals) can’t get rich by inventing and capitalising upon a single new product (look at Red Bull, Dyson, or Swatch), but it’s getting increasingly difficult as mass markets fragment and consumer attention spans evaporate.

For instance, Apple (pre iPod and iTunes) held approximately 1,300 patents and had fanatical brand loyalty. The company was also held up as a poster child of the innovation economy. But Apple had only around 2.5% to 3.0% of the global personal computer market behind grey box brands like Acer and Legend. In contrast, Dell had a share of around 18% of the worldwide market thanks to process innovations like its ‘built-to-order’ production system. In personal terms, Michael Dell is also worth considerably more than Steve Jobs. Dell is the 12th richest person on the planet with around $17 billion, while Jobs languishes in relative poverty in 140th place will around $4 billion. This is ridiculously simplistic, but surely these numbers say something about the value of process versus product innovation?

Another good example is the no-frills airline business. Ryanair (a low-cost European airline) has a higher market cap that most European national carriers. Why? Because no-frills airlines like Ryanair have re-invented flying for millions of people — not through glitzy product or service innovations but via operational innovation.

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Similarly, Wal-Mart isn’t the sexiest retailer from a traditional innovation point of view but they are creative thinkers where it counts. Wal-Mart’s ‘cross-docking’ system (where goods are transferred directly from supplier trucks to store delivery trucks) has been fundamental to logistical efficiency — which in turn allows the company to deliver low prices to customers. It’s not glamorous but it works.

So what’s the take-away here? First, companies must think more radically while simultaneously maintaining an incremental innovation course. Easier said than done of course but there is no easy route to any place worth going.

Second, companies need to focus more on process innovation. This is not innovation process (which they also need) but re-thinking how a market or business currently works and how value could be delivered differently in the future. In other words, companies need to think less about new products and more about how they are delivered via new businesses and new business models.

A final example: Day Jet is a new U.S.-based business that allows business travellers to fly direct to regional airports in six-seater micro-jets. This means that travellers can bypass time-consuming connections at big airports and avoid unwanted overnight stays in small towns and cities. This is a really nice idea, although in theory any airline could buy some micro-jets and do exactly the same. What makes Day Jet innovative is its business model: The company has no fixed routes and no fixed prices. Instead the business aggregates demand ‘on the fly,’ linking small groups of people that want to go to the same place at roughly the same time. Routes and pricing will fluctuate in real time as demands ebbs and flows and customers will be offered a series of different prices depending on how flexible they are willing to be (give a little, save a lot). What’s really clever about this idea is how the business model blends some trends — like mass customisation, dynamic pricing, and social networks to create a product that is extremely difficult to copy.